Introduction
Voluntary sale of vessel to genuine buyer
Creditors' rights – enforcement of mortgages
Bankruptcy
Comment
Companies leasing out equipment for use on board vessels need to be mindful of the legal risks and challenges that exist in protecting legal title to their equipment. This article highlights potential threats and possible mitigation measures.
Leasing equipment for use in the maritime industry may be a practical means for shipowners (the lessee) to cover a short-term need or avoid having to invest in expensive equipment. Typical equipment that is often offered for lease include streamers for seismic operations, remotely operated vehicles, offshore cranes and gangways. Traditionally, leasing services were offered by specialised companies that have leasing as their main business. However, more recently there is a trend towards a broader use of leasing as a business model, where the possibility of leasing equipment is also being offered by equipment manufacturers and others. When entering into this market, it is particularly important for the equipment owner (the lessor) to be mindful of how to protect its legal title to the equipment.
A common feature of leasing is that, while legal title in the equipment is retained by the lessor, physical possession, full care and custody of the equipment is handed over to the lessee. In shipping, this typically involves the equipment being installed on board a vessel and becoming an integrated part of the vessel's operations. Unless mitigating measures are taken, there are certain situations where the lessor risks losing legal title in the equipment.
Some typical examples from a Norwegian law perspective are highlighted below.
Voluntary sale of vessel to genuine buyer
In a situation where the shipowner voluntarily sells the vessel to a third-party buyer with the equipment still on board, the question arises as to whether the lessor can enforce its ownership rights and demand that the equipment is returned to it by the third-party buyer. In this situation the third-party buyer may argue that the vessel was purchased under the assumption that the equipment was part of the vessel and the property of the seller, and thus included in the sale.
According to section 1 of the Norwegian Good Faith Acquisition Act, if an object in the possession of the seller is sold to a genuine buyer (ie, a buyer "in good faith"), then the lawful owner's legal title is extinguished and the genuine buyer assumes legal title. While the lawful owner will likely have a claim for damages against the seller, if the seller is insolvent, such a claim may be almost worthless. Thus, an equipment lessor may lose legal title to the equipment if the vessel buyer in good faith assumes that the seller was entitled to sell the vessel including the equipment.
This risk of extinction in this situation may be mitigated by the lessor by clearly marking the equipment as the property of the lessor. Furthermore, the leasing contract should include specific obligations for the lessee to make such markings clear.
Creditors' rights – enforcement of mortgages
The lessor's legal title may also be threatened where a creditor with a lien against the vessel enforces its claim – for example, where a bank enforces its mortgage due to default under the loan agreement. This will typically lead to a forced sale of the vessel. According to section 45 of the Norwegian Maritime Code (NMC) the ship mortgage comprises not only the vessel itself, but also includes the vessel's "appurtenances". In this case, the question would arise as to whether the equipment on lease would be considered as an appurtenance and thus encompassed by the mortgage. If it is, then the mortgagee may include the equipment as part of the forced sale and the lessor's legal title may be extinguished.
Whether the lessor's equipment is or would be considered an appurtenance would need to be assessed on a case-by-case basis. The general rule, however, is that all equipment intended for long-term use on board the vessel will likely be deemed an appurtenance and thus included as part of the mortgage/lien. There is no requirement for the equipment to be permanently mounted on board the vessel to be considered an appurtenance, nor does it need to be necessary for the operation of the vessel.
A possible measure of mitigation is found in the act itself. According to the NMC (section 45(2)), if the lessee has a right to cancel the lease contract with no more than six months' notice, the equipment will not be deemed part of the mortgage/lien. Consequently, when leasing out equipment at risk of being deemed an appurtenance under section 45 of the NMC, it may be sensible to incorporate into the relevant lease contract a right of termination for the lessee with six months' notice or less. Other possible mitigating measures would require agreement with the mortgagee/creditors.
Finally, a situation may arise where the lessee becomes insolvent and enters into bankruptcy proceedings. The bankruptcy estate may claim that the equipment is part of the estate and that the value of the equipment is to be divided among the creditors of the lessee.
In this situation, the lessor may rely on section 2-2 of the Norwegian Satisfaction of Claims Act. According to this provision, the bankruptcy estate can only seek satisfaction in the property of the debtor at the time of attachment – that is, when bankruptcy is declared. Since the lessor's equipment has never belonged to the lessee – the lessee has only leased the equipment – the bankruptcy estate cannot dispose of the lessor's equipment.
As the examples demonstrate, equipment owners should carefully consider the risks before entering into leasing arrangements in the maritime industry. Retention and protection of legal title should be at the forefront of potential lessors' minds. To achieve this objective, equipment owners should be aware of the need for careful and tailored drafting of the leasing contracts, including, where necessary, taking local law advice.
For further information on this topic please contact Christian James-Olsen, Stian Holm Johannessen or Jens Drageset at Wikborg Rein by telephone (+47 22 82 75 00) or email ([email protected], [email protected], [email protected] or [email protected]). The Wikborg Rein website can be accessed at www.wr.no.